COLUMN-Keystone, the long way round to China: John Kemp

LONDON Feb 8 (Reuters) - Canada badly needs to find a way
to get its crude to customers in Asia and avoid the oversupplied
North American market to fetch a better price for its oil.

Surging output of light sweet oils from North Dakota and
Texas is crowding out demand for heavier, sourer crudes from
Alberta - pushing the price of blends such as Western Canadian
Select (WCS) to a $25 discount against West Texas Intermediate
(WTI) and down as much as $45 against Brent.

Until recently, TransCanada's Keystone XL pipeline
appeared to be the most promising option. If it is eventually
given the go-ahead, Keystone will take crude from Alberta south
across the United States to the U.S. Gulf Coast, from where it
is likely to be loaded onto tankers for export via the expanded
Panama Canal or the Cape of Good Hope to refineries in China,
Korea and Japan.

Enbridge's Northern Gateway pipeline is the main
alternative. It would carry 525,000 barrels a day of Albertan
crude west into British Columbia and across the Rockies to a
marine terminal at Kitimat, where it would be loaded onto
tankers bound for refineries in California or North East Asia.

The problem for Keystone is that its original rationale of
exporting oil to the United States has disappeared. The
replacement aim of exporting to China can be met more sensibly
by developing a western pipeline across the Rockies.

RIVAL ROUTES

The complicated relationship between the rival companies and
rival pipelines was illustrated by an article in Canada's Globe
and Mail newspaper last year.

"What if crude could move to Asia without building huge,
expensive and controversial pipelines to the West Coast (of
Canada)? What if instead of feeding China through Northern
Gateway, Canada sent oil across the Pacific through
TransCanada's proposed Keystone XL line to Texas?" the Globe and
Mail asked ("Why Keystone XL might be Canadian oil's best route
to China" Sept 2012).

Keystone appeared nearer to winning final regulatory
approval. Obama initially refused its application for a
presidential permit in January 2012, demanding more time to
study the pipeline's health and safety as well as environmental
impact.

Until recently, however, it appeared the pipeline would be
approved once the 2012 presidential election was out of the way,
especially once the state of Nebraska pronounced itself
satisfied with changes to the route through the environmentally
sensitive Sand Hills region.

Meanwhile Northern Gateway's approval has been stalled in a
thicket of submissions, hearings and objections before a
government regulatory panel in Canada.

Problems in securing approval for Northern Gateway had
caused many observers to see Keystone as the simpler and more
advanced option.

The U.S. State Department originally said it would complete
its evaluation of Keystone by the end of the first quarter of
2013. But that deadline has now been pushed back to the middle
of the year.

With environmental groups continuing to mount an intense
campaign for the pipeline to be blocked on global warming
grounds, and the Obama administration apparently in no hurry to
finish its national interest review, confidence in Canada that
the pipeline will eventually be approved has fallen sharply.
.

So now hopes for developing an export route have swung back
towards Northern Gateway.

OPPOSITION AND DELAYS

Both pipelines have run into stiff opposition from
environmentalists and communities along the proposed routes.

Keystone appears to have satisfied state governments in all
the U.S. states through which the pipeline would pass.

But it faces continuing strong opposition from environmental
groups who want to block any pipeline at all in the hope of
starving Canadian crude of markets and keeping much of it in the
ground.

Northern Gateway faces opposition from environmentalists.
Many environmental groups are lobbying on both sides of the
border against both pipelines. In addition, it faces strong
objections from First Nations aboriginal tribes such as the
Wet'suwet'en, Cree, Gitxaala and Haisla, over whose lands and
hunting areas it would pass.

Keystone still needs to secure a U.S. presidential permit to
cross the U.S.-Canada border from President Barack Obama before
it can go ahead.

Northern Gateway must still convince a Joint Review Panel
(JRP) of Canada's National Energy Board (NEB) and the Canadian
Environmental Assessment Agency (CEAA) to give it a certificate
of public convenience and necessity (CPCN) and an environmental
assessment authorising construction.

TO CHINA VIA TEXAS

In some ways Northern Gateway is the simpler and more
logical option for exporting to China and the rest of Asia.

Keystone was never intended to take oil to China. It was
meant to take Canadian crude to the complex U.S. refineries
along the U.S. Gulf Coast able to process the bituminous and
sulphurous oil into valuable light products.

But with the unanticipated upsurge in domestic U.S. output,
there is much less demand for heavy Canadian crude.

New U.S. crude streams from North Dakota's Bakken and Texas'
Eagle Ford have a much lower sulphur content and yield a much
higher proportion of low-boiling point molecules suitable for
making gasoline and diesel than Alberta's heavy crudes, making
them much easier and cheaper to process.

Domestic U.S. crudes cannot be exported (except to Canada)
under current U.S. law. So U.S. refineries have a strong
incentive to refine them in preference to Canadian oil. If
Keystone is eventually built and Canadian crude reaches the U.S.
Gulf Coast market, it is likely Canadian crude will be exported
while U.S. oil is refined locally.

Gulf refiners have invested heavily in cokers to handle
heavier crudes such as those produced in Alberta. But those
investments were made before the extent of the shale revolution
became clear, when U.S. refiners expected to source an
increasing proportion of heavy oils from places such as Canada
and Venezuela.

Coking units consume a lot of energy and are expensive to
run. The investment in building them must now be considered a
sunk cost.

Gulf refiners will only buy Canadian crude if it is priced
at a significant discount to shale oils, which would leave
Canadian producers with the same problem albeit probably not
quite as bad as at present.

There is no point trying to export Canadian crude to Europe
where refineries are not equipped to cope with heavy crude. The
only way to unlock the full value of Canadian crude is to export
it to modern giant coking refineries in Asia.

CANADIAN OIL, CANADIAN PIPES?

If Canadian crude is going to end up in Asia, it makes much
more sense to send it west through the Rockies.

The route from Alberta west over the Rockies and across the
northern Pacific is far shorter than taking oil south to Texas
and then putting it on a tanker through the Panama Canal or
around the Cape of Good Hope.

More importantly, it avoids the transit problems of crossing
a third country. While an export pipeline is of clear strategic
importance to Canada, it is not to the United States.

As TransCanada has discovered to its cost, U.S. and Canadian
interests are not aligned on Keystone. In contrast, Northern
Gateway would take Canadian crude across Canada and straight
onto an ocean-going vessel to the final customer.

Canada's federal government, headed by Conservative Prime
Minister Stephen Harper, has indicated it favours the
development of new export pipelines to erase some of the heavy
discounting on Canadian crude - while being careful not to
pre-empt the JRP's regulatory review of Northern Gateway.

Opposition from aboriginal leaders remains intense. Northern
Gateway has become a lightning rod for broader concerns about
the treatment of First Nations by both federal and provincial
governments.

British Columbia's Liberal provincial government is not
enthusiastic either and worried about spills. Northern Gateway
has revealed political divisions between Harper's Conservative
heartland in Alberta (which has virtually no Liberals in its
provincial legislature) and British Columbia (which has no
Conservatives in the provincial assembly).

But given the central role Alberta's oil and gas industry
plays in the Canadian economy, it must be easier for the federal
government to force a pipe across the Rockies than south through
a foreign country.

Pursuing both pipelines would give Canada more export
options and help realise more value for its crude. But if only
one pipeline is going to be built, Northern Gateway might be the
more sensible option.